What will be the new amount demanded of good

Reference no: EM133531433

Question: Suppose there exists a consumer with a Cobb-Douglas utility function.

U = x1 to the power a x2 to the power (1-a)

Recall that in this case, the demand equations are given by the following:
x1 = a m/p1
x2 = (1 - a) m/p2
Suppose the value of a is a = 4/5

Suppose that this consumer has an income of $1,000.

Suppose that the price of good 1 is p1 = $5 and the price of good 2 is p2 = $10.

a) Calculate the amount demanded of good 1 at this initial equilibrium.

b) Suppose the price of good 1 decreased to p1 = $4. What will be the new amount demanded of good 1 at this new equilibrium?

c) This change in consumption of good 1 can be broken down into a substitution effect and an income effect. Calculate these two effects.
d) Is good 1 a normal good, inferior good, or Giffen good? How do you know?

Reference no: EM133531433

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